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Wednesday, 17th April 2024
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Weak interest rates forecast until 2003 Back  
Colin Hunt, head of research at Goodbody Stockbrokers
Despite the aggression of past interest rate moves with the Federal Reserve cutting rates by 300 basis points in the first eight months of the year, it is apparent that the shock to the world economy of recent events will provoke additional interest rate action over the coming months. Specifically, we are now forecasting that the Fed funds rate will be cut by a further 100 basis points over the remaining months of 2001.

The implications of such policy action for longer-term rate levels are reasonably clear. Given that long-term interest rates are primarily determined by expected inflation and growth readings as well as the general stance of fiscal policy, the effort to re-ignite the global economy, if it proves to be successful, will have negative implications for long-term interest rates.

Policymakers on both sides of the Atlantic now have a free hand to stimulate growth without excessive concern for the inflationary consequences of such actions. The policy objective for central bankers has shifted towards underpinning growth and that new policy emphasis, by increasing the chances of a reasonably robust recovery, will be negative for longer-term interest rates. Growth-promoting aggressive rate cuts tend to be followed eventually by reverse policy actions. official interest rates will continue to be moved in the obvious direction while governmental support for economic activity will become more cogent as administrations in both the US and Europe seek to put a meaningful base under growth levels.

Spending restraint and the related attempt to restore good order to government accounts, most notably in Euroland, is likely to be suspended temporarily with a dose of good, old Keynesian pump-priming set to supersede the rigid requirements of the Stability and Growth Pact. Talk of bond buyback programmes will fade and governments are likely to find it necessary to turn increasingly to the bond markets for day-to-day financing requirements over the course of the next eighteen months. That too, through the increased demand for bond market resources, will be negative for longer-term interest rates.

Finally, we come to inflation pressures. While fiscal and monetary policies will create a growth-friendly environment, this is unlikely to be accompanied by the normal response in terms of prices. A rush for growth has, in the past, led to an inflationary backlash with excessively stimulative policies putting upward pressure on price levels and, as a consequence, on long-term interest rates. However, given the abundance of economic capacity on a global basis, the weak base from which we see growth recovering and the increasing freedom of global trade movement, we expect the inflation response to be subdued in the forthcoming recovery cycle.

Taking the negative policy and the neutral inflation factors into consideration, I would expect to see long-term rates in both Europe and the US increasing by some 50 basis points over the course of the coming three months with a further 50 basis points in storage for the recovery in 2002.

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